Passporting: What is it? And why will Brexit matter?

Passporting: What is it? And why will Brexit matter?

written by

Sean Halliwell

13th March 2017

Passporting: What is it? And why will Brexit matter?

The potential implications of Brexit for the financial services sector in the UK are vast, particularly as much of UK law is from, or is heavily influenced by, the EU. A major concern for UK financial institutions is the awaited loss of “passporting” rights.

“Passporting” currently gives British financial institutions the right to offer their financial services anywhere in the EU and in the European Economic Area (EEA) by virtue of being based in (and regulated in) the UK without incurring the expense or inconvenience of obtaining additional licences in other member states. It is estimated that over 300,000 financial passports are at risk once Article 50 is triggered and the UK begins negotiations to leave the EU.

In January 2017, Theresa May confirmed that the UK will not seek to remain a member of the single market. Accordingly, the UK will not be a member of the EEA after leaving the EU and UK financial institutions will inevitably lose passporting rights, unless alternative access to such financial markets is somehow agreed before the UK exits the EU. The Prime Minister suggested that the UK will attempt to keep a certain degree of flexible market access following its departure from the EU, although it is very unclear as to whether the UK will seek to simply replicate the existing passporting arrangements or rely on “third country” regimes.

Third country regimes and equivalence

A “third country” (when interpreting EU legislation) is a jurisdiction that is not part of the EEA (as the UK is expected to be following its departure from the EU). There are currently only two EU legislative acts that contain provisions allowing financial institutions based in such third countries to gain access to EEA markets and in both cases, the acts contain a precondition that the third country’s regulatory regime has been deemed to be “equivalent” to that of the EU.

Unfortunately it is unclear as to whether the UK would be deemed to be an equivalent regime once it becomes a third country. The UK has implemented EU financial services legislation as a member of the EU so it would appear to be a relatively straightforward process for our regulatory regime to be considered equivalent. However, this process is likely to be extensive and (as the European Commission ultimately decides on this) it will be subject to political considerations. A big weakness with “equivalence” is the fact that the UK would have to preserve regulatory rules equivalent to the EU to benefit from it without a say in how such regulations may change in the future which seems unfeasible given the government’s move towards a “hard-Brexit”.

Other potential forms of access

UK financial institutions could incorporate a separate group company in an EU member state and obtain authorisation to carry out financial services from the local regulator and use its passport rights to provide cross-border services and activities in the EU. However this is likely to be a very expensive and laborious process; the more complex the financial institution’s business is, the longer it will take to obtain authorisation from the local regulator.

It is also feasible for UK financial institutions to apply to be directly authorised by a local regulator in each relevant EU member state (even if they are not established in that member state). However, such direct authorisation is usually only given where an institution intends to establish a branch in that member state and, in practice, not all member states would consider such an application.

Bespoke free trade agreement

A potential solution would be for the UK to enter into a form of free trade agreement (FTA) with the EU that covers, among other issues, cross-border financial services and market access to EU markets for UK financial institutions. Theresa May alluded to this in her January 2017 speech and the government’s subsequent white paper on the UK’s exit from and new partnership with the EU, published in February 2017, unfortunately added little to what such an FTA may include but did state that the UK was aiming for the “free-est possible trade” in financial services between the UK and EU member states.

The paper also stated that the UK would attempt to reach an agreement on a “phased process of implementation” suggesting that this process might relate to the future legal and regulatory framework for business. Given the timescales, a phased process of implementation may be the only viable option if there is to be negotiation and agreement on this in time for the UK’s exit from the EU. By way of comparative example, Canada entered into negotiations with the EU for an FTA in May 2009 which was only signed and finalised on 30 October 2016.

The UK remains the world’s leading provider of financial services and it appears unlikely that the EU would reject an FTA. It is likely that any FTA would alter passporting rights as we know them (for example, certain services may now be restricted or may be conditional on the UK institution having a branch in that member state) which will largely be dictated by how much the EU’s financial institutions are able to provide their own input into such an agreement. “Equivalence”, despite being limited in nature (particularly as it will not be relevant to a large part of the UK’s financial services sector (including commercial banking)), is also likely to be utilised by the UK in such an agreement as a means of forming a base framework for gaining access to EU financial markets.

Conclusion

Financial services are likely to suffer the biggest impact of Brexit but this will depend heavily on the exit arrangement(s) in place. If no FTA or equivalent deal is reached, the government intends to take steps intended to mitigate the impact on economic and other functions, including passing legislation if necessary. Whatever happens, London is a dominant global financial hub and will remain an important EU asset. Accordingly, it is expected that financial institutions will, in the absence of access to the EEA or an FTA being agreed in time, retain a base in the UK even if they have to set up EU subsidiaries to gain access to the EEA. This has already been alluded to by new challenger bank, ClearBank, in February 2017 and steps have already been taken by insurance giant, AIG, on 9 March 2017 to this effect.

If you would like further information about this article or topic, please contact Sean Halliwell on 0345 070 6000.